Solution Manual for Fundamentals of Corporate Finance 11CE | Ross, Westerfield, Jordan | All Chapters 1–26

SOLUTION MANUAL FORM M


FundamentalsMOfMCorporateMFinanceM11ceMStephenMA.MRoss,MRandolphMW.MWesterfield,
MBradfordMD.MJordan,MJ.MAriMPandes,MThomasMHolloway



Chapter 1-26 M




CHAPTER 1 M


INTRODUCTION TO CORPORATE FINANCE
M M M



LearningMObjectives

LO1M TheMbasicMtypesMofMfinancialMmanagementMdecisionsMandMtheMroleMofMtheMfinancialMmanager.
LO2M TheMfinancialMimplicationsMofMtheMdifferentMformsMofMbusinessMorganization.
LO3M TheMgoalMofMfinancialMmanagement.
LO4M TheMconflictsMofMinterestsMthatMcanMariseMbetweenMmanagersMandMowners.
LO5M TheMrolesMofMfinancialMinstitutionsMandMmarkets.
LO6M TypesMofMfinancialMinstitutions.
LO7M TrendsMinMfinancialMmarkets.

AnswersMtoMConceptsMReviewMandMCriticalMThinkingMQuestions

1. (LO1)MCapitalMbudgetingM(decidingMonMwhetherMtoMexpandMaMmanufacturingMplant),McapitalMstructu
reM(decidingMwhetherMtoMissueMnewMequityMandMuseMtheMproceedsMtoMretireMoutstandingMdebt),MandM
workingMcapitalMmanagementM(modifyingMtheMfirm‘sMcreditMcollectionMpolicyMwithMitsMcustomers).M
(LO1)

2. (LO2)MDisadvantages:MunlimitedMliability,MlimitedMlife,MdifficultyMinMtransferringMownership,MhardMt
oMraiseMcapitalMfunds.MSomeMadvantages:Msimpler,MlessMregulation,MtheMownersMareMalsoMtheMmanag
ers.

3. (LO2)MTheMprimaryMdisadvantageMofMtheMcorporateMformMisMtheMdoubleMtaxationMtoMshareholdersMo
fMdistributedMearningsMandMdividends.MSomeMadvantagesMinclude:MlimitedMliability,MeaseMofMtransfer
ability,MabilityMtoMraiseMcapital,MunlimitedMlife,MandMsoMforth.

4. (LO4)MTheMtreasurer‘sMofficeMandMtheMcontroller‘sMofficeMareMtheMtwoMprimaryMorganizationalMgrou
psMthatMreportMdirectlyMtoMtheMchiefMfinancialMofficer.MTheMcontroller‘sMofficeMhandlesMcostMandMfin
ancialMaccounting,MtaxMmanagement,MandMmanagementMinformationMsystems,MwhileMtheMtreasurer‘sM
officeMisMresponsibleMforMcashMandMcreditMmanagement,McapitalMbudgeting,MandMfinancialMplanning.M
Therefore,MtheMstudyMofMcorporateMfinanceMisMconcentratedMwithinMtheMtreasuryMgroup‘sMfunctions.

5. (LO3)MToMmaximizeMtheMcurrentMmarketMvalueM(shareMprice)MofMtheMequityMofMtheMfirmM(whetherMi
t‘sMpublicly-tradedMorMnot).

6. (LO4)MInMtheMcorporateMformMofMownership,MtheMshareholdersMareMtheMownersMofMtheMfirm.MTheMsh
areholdersMelectMtheMdirectorsMofMtheMcorporation,MwhoMinMturnMappointMtheMfirm‘sMmanagement.MT
hisMseparationMofMownershipMfromMcontrolMinMtheMcorporateMformMofMorganizationMisMwhatMcausesMa
gencyMproblemsMtoMexist.MManagementMmayMactMinMitsMownMorMsomeoneMelse‘sMbestMinterests,Mrath
erMthanMthoseMofMtheMshareholders.MIfMsuchMeventsMoccur,MtheyMmayMcontradictMtheMgoalMofMmaximi
zingMtheMshareMpriceMofMtheMequityMofMtheMfirm.

7. (LO5)MAMprimaryMmarketMtransaction.MAMsecondaryMmarketMtransactionMwouldMentailMtheMsaleMbet
weenMtwoM3rdMpartiesM(i.e.MnotMtheMcorporation).



RossMetMal,MFundamentalsMofMCorporateMFinanceM11thMCanadianMEditionMSolutionsMM
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,8. (LO5)MInMauctionMmarketsMlikeMtheMTorontoMStockMExchangeM(TSX),MbrokersMandMagentsMmeetMatM
aMcentralMlocationM(theMexchange)MtoMmatchMbuyersMandMsellersMofMassets.MPhysicalMlocationsMforMst
ockMmarketsMareMdisappearingMasMtradingMbecomesMmoreMelectronic.MDealerMmarketsMlikeMNasdaqMc
onsistMofMdealersMoperatingMatMdispersedMlocalesMwhoMbuyMandMsellMassetsMthemselves,Mcommunicat
ingMwithMotherMdealersMeitherMelectronicallyMorMliterallyMover-the-
counter.MDealerMmarketsMareMlessMtransparentMthanMauctionMmarketsMwhereMtradesMareMreportedMpubl
iclyMalmostMimmediately.M TheMauctionMmarketMrunMbyMtheMTSXMisMwhereMtheMstocksMofMlargerMCa
nadianMcompaniesMareMtraded;MtheMTSXMalsoMoperatesMaMdealerMmarketMcalledMtheMVentureMExchan
geMforMcompaniesMtooM smallMtoMqualifyMforMtheMTSXMauctionM exchange.




9. (LO3)MSuchMorganizationsMfrequentlyMpursueMsocialMorMpoliticalMmissions,MsoMmanyMdifferentMgoals
MareMconceivable.MOneMgoalMthatMisMoftenMcitedMisMrevenue Mminimization;Mi.e.,MprovideMwhateverMg

oodsMandMservicesMareMofferedMatMtheMlowestMpossibleMcostMtoMsociety.MAnotherMwouldMbeMtoMbestM
serveMtheMmaximumMpossibleMnumberMofMstakeholdersMatMtheMlowestMcost.MAMbetterMapproachMmigh
tMbeMtoMobserveMthatMevenMaMnot-for-
profitMbusinessMhasMequity.MThus,MoneManswerMisMthatMtheMappropriateMgoalMisMtoMmaximizeMtheMval
ueMofMtheMequity.

10. (LO3)MPresumably,MtheMcurrentMstockMvalueMreflectsMtheMrisk,Mtiming,MandMmagnitudeMofMallMfuture
McashMflows,MbothMshort-termMandMlong-term.MIfMthisMisMcorrect,MthenMtheMstatementMisMfalse.



11. (LO3)MAnMargumentMcanMbeMmadeMeitherMway.MAtMtheMoneMextreme,MweMcouldMargueMthatMinMaMma
rketMeconomy,MallMofMtheseMthingsMareMpriced.MThereMisMthusManMoptimalMlevelMof,MforMexample,Met
hicalMand/orMillegalMbehavior,MandMtheMframeworkMofMstockMvaluationMexplicitlyMincludesMthese.MAt
MtheMotherMextreme,MweMcouldMargueMthatMtheseMareMnon-

economicMphenomenaMandMareMbestMhandledMthroughMtheMpoliticalMprocess.MAMclassicM(andMhighlyM
relevant)MthoughtMquestionMthatMillustratesMthisMdebateMgoesMsomethingMlikeMthis:M―AMfirmMhasMest
imatedMthatMtheMcostMofMimprovingMtheMsafetyMofMoneMofMitsMproductsMisM$30Mmillion.MHowever,Mth
eMfirmMbelievesMthatMimprovingMtheMsafetyMofMtheMproductMwillMonlyMsaveM$20M millionMinMproductM
liabilityMclaimsMandMlostMcustomerMgoodwill.MWhatMshouldMtheMfirmMdo?‖

12. (LO3)MTheMgoalMwillMbeMtheMsame,MbutMtheMbestMcourseMofMactionMtowardMthatMgoalMmayMbeMdiffe
rentMbecauseMofMdifferingMsocial,Mpolitical,MandMeconomicMinstitutions.

13. (LO4)MTheMgoalMofMmanagementMshouldMbeMtoMmaximizeMtheMshareMpriceMforMtheMcurrentMsharehol
ders.MIfMmanagementMbelievesMthatMitMcanMimproveMtheMprofitabilityMofMtheMfirmMsoMthatMtheMshareM
priceMwillMexceedM$35,MthenMtheyMshouldMfightMtheMofferMfromMtheMoutsideMcompany.MIfMmanageme
ntMbelievesMthatMthisMbidderMorMotherMunidentifiedMbiddersMwillMactuallyMpayMmoreMthanM$35MperMsh
areMtoMacquireMtheMcompany,MthenMtheyMshouldMstillMfightMtheMoffer.MHowever,MifMtheMcurrentMmana
gementMcannotMincreaseMtheMvalueMofMtheMfirmMbeyondMtheMbidMprice,MandMnoMotherMhigherMbidsMco
meMin,MthenMmanagementMisMnotMactingMinMtheMinterestsMofMtheMshareholdersMbyMfightingMtheMoffer.M
SinceMcurrentMmanagersMoftenMloseMtheirMjobsMwhenMtheMcorporationMisMacquired,MpoorlyMmonitored
MmanagersMhaveManMincentive MtoMfightM corporateMtakeoversMinMsituationsMsuchMasMthis.



14. (LO4)MWeMwouldMexpectMagencyMproblemsMtoMbeMlessMsevereMinMotherMcountries,MprimarilyMdueMt
oMtheMrelativelyMsmallMpercentageMofMindividualMownership.MFewerMindividualMownersMmeansMthatM
eachMindividualMownerMhasMaMgreaterMincentiveMtoMmonitorMandMcontrolMtheMfirm—
i.e.MthereMisMlessMfree-
riding.MTheMhighMpercentageMofMinstitutionalMownershipMmightMleadMtoMaMhigherMdegreeMofMagreeme
ntMbetweenMownersMandMmanagersMonMdecisionsMconcerningMriskyMprojects.MInMaddition,Minstitutions
MmayMbeMbetterMableMtoMimplementMeffectiveMmonitoringMmechanismsMonMmanagersMthanMcanMindiv

idualMowners,MbasedMonMtheMinstitutions‘MdeeperMresourcesMandMexperiencesMwithMtheirMownMmanag
ement.MTheMincreaseMinMinstitutionalMownershipMofMstockMinMCanadaMandMinMtheMUnitedMStatesMand
MtheMgrowingMactivismMofMtheseMlargeMshareholderMgroupsMmayMleadMtoMaMreductionMinMagencyMpro

blemsMforMCanadianMandMU.S.McorporationsMandMaMmoreMefficientMmarketMforMcorporateMcontrol.
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,15. (LO5)MMajorMinstitutions:
CharteredMbanksM-
acceptMdepositsMandMissueMcommercialMloans,McorporateMloans,MpersonalMloansMandMmortgages.
TrustMcompanies-
acceptMdepositsMandMmakeMloans,MbutMalsoMengageMinMfiduciaryMactivitiesMsuchMasMmanagingMassets
MforMestates,MregisteredMretirementMsavingsMplans,Metc.

InvestmentMdealersM-non-depositoryMinstitutionsMthatMassistMfirmsMinMissuingMnewMsecurities.
InsuranceMcompaniesM-
engageMinMindirectMfinancingMbyMacceptingMfundsMinMaMformMsimilarMtoMaMdepositMandMmakingMloan
s.
PensionMfundsM-
investMcontributionsMfromMemployersMandMemployeesMinMsecuritiesMofferedMbyMfinancialMmarkets.
MutualMfundsM-poolMindividualMinvestmentsMtoMpurchaseMaMdiversifiedMportfolio.
HedgeMfundsM-
caterMtoMsophisticatedMinvestorsMandMseekMhighMreturnsMbyMusingMaggressiveMfinancialMstrategiesMpr
ohibitedMbyMmutualMfunds.
NoteMthatMlargerMfinancialMinstitutionsMmayMembodyMmanyMofMtheseMdifferentMinstitution.MForMexam
ple,MCIBCMisMaMcharteredMbankMthatMownsManMinvestmentMdealerMandMmutualMfunds.MFurthermore,Mi
tMhasManMinsuranceMarmM―CIBCMInsurance‖

MajorMmarkets:
MoneyMmarketM-financialMmarketsMwhereMshort-termMdebtMinstrumentsMareMboughtMandMsold.
CapitalMmarketsM-financialMmarketsMwhereMlong-
termMdebtMandMequityMsecuritiesMareMboughtMandMsold.MDerivativesMmarketsM–
MwhereMoptionsMandMfuturesMareMtradedMonMfinancialMinstrumentsMandMcommoditiesMPrimaryM marke

tsM areM whereM securitiesM areM soldM forM theM firstM time;M secondaryM marketsM areM whereMoutstandin
gMsecuritiesMtrade.

16. (LO5)MSpreadMversusMFeeMIncome:
BanksMearnMspreadMorMinterestMincomeMbyMborrowingMfromMdepositorsMandMlendingMtoMborrowersM(atMaMh
igherMyield).MAnMexampleMisMaMretailMdepositMandMaMmortgage.MBanksMmakeMnon-
interestMorMfeeMincomeMwhenMtheyMchargeMcommissionsMorMfeesMforMservices.MAnMexampleMisManMoverdra
ftMfeeMorMATMMfee,MorMtheMexampleMinMtheMtext,MtheMstampingMfeeMonMaMbanker‘sMacceptanceM(whichMis
MaMformMofMinsuranceMandMarrangingMfee).




17. (LO5)MTrends:
FinancialMengineeringM-
theMcreationMofMnewMsecuritiesMorMfinancialMprocesses.MThisMengineeringMcouldMbeMusedMtoMpackage
MandMsellMriskyMassetsMtoMinvestors;MforMexample,MbanksMcanMpackageMandMsellMmortgagesMintoMmor

tgageMbackedMsecuritiesMandMsellMtheseMonMtoMotherMinvestors.

DerivativeMsecuritiesM-
options,Mfutures,Mforwards,MandMotherMsecuritiesMwhoseMvalueMisMderivedMfromMtheMpriceMofManother
,MunderlyingMasset.M ForMexample,MaMfuturesMcontractMtoMpurchaseMoilMsetsMaMfixedMpurchase/sellingM
priceMforMaMfutureMdate,MbutMitsMvalueMdependsMonMtheMpriceMofMoil.MTheseMderivativesMcanMhelpMbu
sinessesMdivestMrisksMthatMareMnotMcoreMtoMtheirMbusiness,MsuchMasMforeignMexchangeMandMinputMpric
eM(likeMoil)Mrisk.

RegulatoryMdialecticM-
theMpressuresMthatMfinancialMinstitutionsMandMregulatoryMbodiesMexertMonMeachM other.M ForMexample,
MwhenMrestrictionsMareMremoved,MgrowthMopportunitiesMmayMincrease.M However,MtheMabsenceMofMre

gulatoryMrestrictionsMmayMalsoMleadMtoMproblemsMsuchMasMtheMglobalMfinancialMcrisisMstartingMinM20
07McausedMbyMexcessiveMfinancialMleverage,MsoMitMisMimportantMthatMthereMbeManMappropriateMlevelM
ofMregulatoryMoversight.

ESGM–
InvestorsMandMcorporationsM(andMtheirMmanyMstakeholders)MareMincreasinglyMfocusedMonMEnvironme
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, ntal,MSocietal,MandMGovernanceMissues.MThisMincludesMemployeeMandMcustomerMwelfareMasMwellMasM
climateMchangeMandMpollution.




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